The price on your letter of intent is not your price. Your price is whatever survives the next 45 days.
The average retrade, which is when a buyer comes back mid-deal asking for a reduction, takes back more money than most owners will save negotiating commission all year. So this is how due diligence works, and how to make sure the number you agreed to is the number you close on.
Due diligence is a second negotiation
You think it is an inspection. Something to get through. He shows up, he looks around, he confirms what you told him.
He thinks it is a second negotiation, and this time he has better information than he did the first time. Only one of you is preparing for what is actually happening.
This is not bad faith on his part. It is his job. His lender requires it, his investors expect it, and every buyer does it. The only problem is that most sellers do not know the game has restarted.
The deal timeline, and the one date to write on the wall
- Letter of intent. Nonbinding. Sets price and basic terms.
- Purchase and sale agreement. Binding. The deposit goes into escrow.
- Due diligence period. Usually 30 to 45 days. During this window his deposit is refundable, which means he can walk for any reason at all.
- The deposit goes hard. After that date, his money is at risk if he walks.
- Financing contingency.
- Closing.
Step 4 is the single most important date in your deal. Know your hard money date and write it on a wall. Before that date, almost all the negotiating power is his. After it, a meaningful amount of it comes back to you.
Do not negotiate the length of due diligence down just to look accommodating. A buyer who needs 45 days and gets 30 will ask for an extension at day 28. He will ask for it at the point where you have already turned other interest away.
Four inspection tracks running at once
- Physical. Roof, mechanicals, structure, and a walk of the units. Expect him to want access to every unit, or close to it.
- Financial. Leases compared against your rent roll. Bank deposits compared against your reported income. This is where a sloppy rent roll turns into a real problem.
- Legal and title. Survey, zoning, open permits, code violations, and estoppel certificates from your tenants confirming their lease terms.
- Environmental. Usually a Phase I environmental report. Underground tanks, a dry cleaner next door, historical uses of the site.
Four sets of people, all running at once, all reporting back to the same buyer.
Be present for the physical inspection, or have somebody there who knows the building. Inspectors write down what they see. If nobody explains that the stained ceiling is from a leak repaired two years ago, with an invoice to prove it, it goes into the report as an active problem.
The financial track is the one you can get ahead of from your desk. The rent roll checks in How to Prepare a Small Apartment Building for Sale are the same comparisons the buyer’s team runs during the lease audit.
Buyers do not retrade on problems. They retrade on surprises
This is the line that makes some owners uncomfortable. Every surprise in your deal is one you chose not to disclose.
A $30,000 roof that you disclose up front is a price negotiation. You handle it once, in daylight, and you move on.
That same roof, discovered by his inspector in week four, is not a roof problem anymore. It is a credibility problem. Now he is wondering what else you did not mention, and he starts pricing that uncertainty into everything.
So build a disclosure list before the building goes on the market:
- Every open item.
- Every deferred repair.
- Every quirk in the building.
Hand it over early. It costs you a little in the price negotiation, and it saves you a great deal in week four.
Want to know where your building stands before a buyer’s team does? The Exit Navigator Scorecard walks you through what a buyer will look at, so the list you build is yours and not his.
What a retrade costs in dollars
A 3 percent retrade on a $4 million building is $120,000.
Now compare that to disclosing the same issues at the start. Say the real repair number is $35,000. You disclose it, you credit it or you fix it, and it costs you $35,000.
Same set of facts. An $85,000 difference, decided entirely by when the information came out, and who found it.
The building did not change between those two columns. The market did not change. The only thing that changed was the order of events, and the order of events is the part you control.
Marcus, in week three
Take Marcus and his twelve units. His file carried a rent roll mismatch, and it surfaced again during the lease audit, which is exactly where it was always going to surface.
By itself it was worth almost nothing. Some renewal dates were wrong.
But it arrived in week three, from the buyer’s side, not from Marcus. After that, every number in the file got a second look. That is the cost of being the one who did not find it first.
Walk your building the way his inspector will
For each of the four tracks, write down what a buyer’s team will find, and put it on your disclosure list before you go to market.
Then find your hard money date in the contract the day it is signed, and plan around it. Leave the due diligence period at the length the buyer needs.
If you want to see your building the way a buyer’s team will see it, start with the Exit Navigator Scorecard. If you want a read on the number before a letter of intent ever arrives, start with the Value Navigator.
Ask yourself one question tonight. If a buyer walked your building tomorrow, what is the one thing you would rather he not find? That item goes at the top of your disclosure list.
Selling in Washington DC, Virginia, or Maryland? Read Selling a DC Apartment Building before you sign a letter of intent.
Frequently asked questions
How long is due diligence on an apartment building sale? Usually 30 to 45 days. During that window the buyer’s deposit is refundable, so he can walk for any reason at all. Do not negotiate the period down just to look accommodating, because a buyer who needs 45 days and gets 30 will ask for an extension at day 28.
What is the hard money date and why does it matter? It is the date the buyer’s deposit goes hard. After it, his money is at risk if he walks. Before that date, almost all the negotiating power is his. After it, a meaningful amount of it comes back to you. It is the single most important date in your deal.
What is a retrade? A retrade is when a buyer comes back mid-deal asking for a price reduction. Buyers do not retrade on problems. They retrade on surprises, and every surprise in your deal is one you chose not to disclose.
How much does a retrade cost compared to disclosing up front? A 3 percent retrade on a $4 million building is $120,000. If the real repair number behind it is $35,000 and you disclose it at the start, you credit it or fix it for $35,000. Same facts, an $85,000 difference, decided by when the information came out and who found it.